What is a Private Mortgage?: Understanding Hard Money Lenders

Considering the complexities of today’s real estate market, many potential buyers are asking themselves, “Should I buy a house now?” In many places, the current market is a seller’s market, which means that it’s easier than ever for people who are selling their properties to make a lot of money.

However, buyers may need additional financial support to meet a seller’s expectations. Enter the private mortgage. Real estate purchases financed by friends, family, and private institutions come attached to fewer strings than traditional bank mortgages. Private mortgages also allow for greater flexibility in today’s challenging market.

What is a Private Mortgage?

You do not apply for a private mortgage through a bank or a mortgage lender. Instead, private mortgages are just that — private. When you reach out to family, friends, and business acquaintances for support with purchasing your new home, you can benefit from a non-institutionalized private mortgage.

The informal nature of these loans can benefit the borrower immensely but it can also put additional stress on personal relationships. To successfully establish a private mortgage, it’s in the best interest of the borrower to create an interest-forward contract, like a mortgage note or comparable contract, which will ensure that no one ends up getting shorted.

Two Ways You Can Use Private Lender Loans

Private mortgages aren’t single-use loans. Borrowers can use these mortgages to purchase a new property or refinance an existing property!

Purchase a New Property

The housing market is in a tricky place as of 2022. It is a seller’s market, which means that buyers need to step up their game if they want to purchase the property of their dreams.

Parties that are interested in securing a private loan should express their interest early on so that they are prepared to make an offer when the right multi-family or residential property comes along.

People who are interested in commercial investments can lean into the potential financial gain of those properties to more effectively secure the financing they need from private sources, too.

Refinance an Existing Property

Feeling confined by a traditional mortgage? Private mortgage lenders can help borrowers rather than the lenders or banks that the borrowers have worked with in the past.

The Pros of a Private Mortgage

Private mortgages are popular with lenders and borrowers alike for a myriad of reasons, including the following!

For the Lender

Private mortgages come with higher-than-average interest rates. As such, private lenders can more easily make money off of their investments.

For the Borrower

Borrowers may have specific benefits, too, which include shorter approval times and the ability to buy a house with the intention of flipping it.

Shorter Approval Times

While private mortgage lenders will still want to consider a borrower’s credit score and pay-back history, the loan approval rates between family and friends tend to be a lot faster than when you apply for loans through banks.

Banks and public lenders require a significant amount of documentation before they will approve a mortgage. With a borrower’s loved ones, their relationship with the borrower will be enough of a character reference for them to base their decision off of.

Flip That House

Buying a house with the intention of flipping it is easier with a private mortgage than with a bank. If borrowers can sell the homes that they finance and flip them for more than the cost of their private mortgage, then they can make a profit on their work without worrying about the limitations and regulations set by a traditional bank.

The Cons of a Private Mortgage

Banks and public mortgage lenders have risen in popularity for a reason. These institutions have established, federally-directed policies that protect both themselves and their borrowers.

Parties that pursue a private mortgage, both as lenders and borrowers, may subsequently face challenges that the world of public financing doesn’t experience.

For the Lender

There are several drawbacks to choosing a private mortgage as a lender. These downsides include a short payback period and the potential to default on the loan.

Short Payback Period

One of the greatest private mortgage lender benefits is the chance to arrange for a substantial interest rate. However, the mortgage’s short payback period means that lenders won’t have the chance to benefit from the additional income for too long.

Lenders need to plan out their future finances with care if they want to make the most of a borrower’s interest.

The Potential to Default

There is always a chance that, despite the financial support that a lender offers, the borrower may default on their mortgage. While the borrower has the opportunity to declare bankruptcy, lenders who are interested in regaining the investments they lost may have to undergo a complicated and costly legal process.

For the Borrower

Likewise, there are several drawbacks of a private mortgage for borrowers. These include an even shorter payback period and higher interest rates.

Shorter Payback Period

Traditional mortgages often allow the borrower to pay back the loan and the interest over a term of thirty years or more. But this isn’t the case with private mortgages which have a notably shorter payback period.

As such, borrowers will need to manage their finances carefully to prevent bankruptcy as the result of taking out a substantial loan.

Higher Interest Rates

Even though they are established in an informal environment, private mortgages still require paperwork in order to protect a private mortgage lender’s interest. As such, these loans will also likely include interest.

While borrowers can avoid the complexity of working with a bank or other institution, they’ll face interest rates that are substantially higher if they choose to go the route of a private mortgage. This cost can transform a borrower’s financial plans both for the immediate future and for life down the road.

Tips for Your Private Mortgage

Borrowers and lenders alike can use private mortgages to their advantage. To ensure a mutually beneficial arrangement, both parties may want to establish an interest rate in writing and plan for things to go awry.

Establish an Interest Rate in Writing

All lenders establishing private loans must require their borrowers to pay interest equal to the IRS Applicable Federal Rate. Many lenders are encouraged to charge more, both for the borrower’s tax benefits and for their own financial gain. With that being said, the exact amount of interest that a private mortgage lender charges is up to the individual.

Both the borrower and the lender will then want to establish their fixed tax rate in writing to ensure that it’s easier to report on legal financial documents. It will also prevent either party from attempting to change the fixed rate later on down the road.

Plan for Things to Go Awry

Lenders and borrowers alike face a distinct risk of financial disaster if they improperly handle a private mortgage. That’s why both parties will want to establish contingency plans during their initial conversations.

Writing in provisions for borrower defaults and missed payments can keep the relationship between a borrower and lender civil without compromising either party’s financial standing.

Buying a House with a Private Mortgage: Your Next Steps

Private mortgages benefit lenders and borrowers alike. As long as all parties involved in the process make financially-sound decisions, you won’t need to ask yourself, “Should I buy a house now?” for long. Sit down with your friends, family, or a private institution to determine whether a private mortgage lender agreement can help you purchase the property of your dreams.


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This page last updated: March 21, 2022